Fed Rate hike: Time to Prepare for a 2008-Like Crisis? - Views on News from Equitymaster

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The Equitymaster Research Digest

Fed Rate hike: Time to Prepare for a 2008-Like Crisis?
Dec 16, 2016

The US Fed didn't exactly spring a surprise the day before yesterday, but it did make a break from the past. And it seems the break is going to be pretty severe. Brace yourself for a series of rate hikes over the next couple of years.

The reason the US Fed's every move is so closely tracked is because the Fed rate has an impact on every investment imaginable. The Fed rates act on asset valuations like gravity acts on matter. The higher the rate, the greater the downward pull. So if the Fed hikes rates, the price of all the other investments must adjust downward, to a level that brings their expected rates of return into line. The converse is also true.

The underlying theory is this: How much an investor should pay today to receive a dollar tomorrow can only be determined by first looking at the risk-free interest rate.

And the risk-free rate is on the brink of a tectonic shift. Please note when rates move from 6% to 8%, it's only a 33% change. But when rates change from 0.5% (the level before the current rate hike) to 2% (a strong possibility over the next two years), rates have quadrupled.

You can imagine the kind of downward pull in terms of valuations this could lead to.

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